Peter Bernstein, one of the most senior investment advisers currently in practice, and the author of many excellent investment books, has recently presented an argument that the long-standing relationship of stock yields and bond yields may be close to reversing. Before 1958, stock dividends yields had been higher than bond yields since the 1870's. Bernstein recalls that his senior partners in 1958 were convinced this was a short-lived anomaly, but that it has persisted to the present. After all, stocks were inherently more risky than fixed income bonds, in the then current and long time view, and so they should pay a higher dividend. But during the sharp recession of 1958 (-10% rate of change in GDP), inflation increased and bond rates finally rose above stock dividend rates. It was unheard of for inflation and bond yields to increase during a sharp recession.
Bernstein understood that the growth stock ideology was just getting started, indeed he had trumpeted it two years earlier in the Harvard Business Review. The new ideology, which we now accept as eternal truth, was that growth stocks would have superior and accelerating cash flows and dividends far beyond a fixed rate bond so that current stock dividends were immaterial, so they should pay a smaller dividend than bonds. And so it was. Until 1999. Since 1999 the ten year US Treasury yield has fallen from about 6.5% to 4% while the SPX yield has risen from nearly 1% to nearly 3%, and recent SPX price losses may boost that yield to 4%.
However, the second part of Bernstein's observation is that during the inflation that followed the 1960's, SPX dividend growth kept up with inflation as did bond yields. Mind you that as a result of this stocks rose until 1972-73 generally, while bonds fell. The positive correlation of bond and stock yields continued all through the 1980's and 90's as both yields fell and both stocks and bonds therefore rose. But as we have seen above, this trend has reversed since 1999-2000 when inflation rekindled.
Bernstein now wonders if current difficulties in the economy will result in stocks falling far more and Treasury bonds rising far further (yields lower), in which case stock dividend yields could far exceed Treasury yields for the first time since 1958. Furthermore, he points to the lag of inflation-adjusted US incomes compared to increased productivity as a major political issue which may impede corporate earnings and lead to much lower stock prices. He implies this would be the reason for a reversal of the 1958 crossover of Treasury yields above SPX dividend yields.
Bernstein's analysis is very subtle and extremely perceptive as only a seasoned observer can be, far beyond most current commentators. Personally, however, I believe the feasible rebuttal lies in the same inflationary experience that began in the late 1950's and which has begun again since the turn of this century, namely inflation itself. Stocks may not do as well during inflation as during benign disinflation, but they do better than bonds. So earnings, after the recession, and dividends, will rise, but probably not as fast as Treasury bond yields, so stocks will be a better investment than fixed income Treasury bonds, just as they were in the 1960's and 1970's. This is totally compatible with the Economic Long Wave which predicts the same outcome. Inflation will decimate bonds but earnings and dividend growth of substantial corporations will partially protect them. For better protection one will want to be invested in inflation hedges such as selected currencies, metals, and commodities either directly or via equity-linked vehicles.
For a copy of the Bernstein article contact [email protected] from whom I received my copy or http://www.peterlbernsteininc.com/
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